Dan Egan is the Director of Behavior Science and Investing at the online advisor, Betterment. In launching this rather unique career, Dan levered a Masters degree in Decision Science at the London School of Economics into a role as Behavioral Finance Specialist at Barclays Wealth in London before moving on to Betterment. With 15 years operating at the cross-section between human behavior and markets he is one of the world’s foremost experts in this field.

To kick off the discussion I wanted to know: What do investors really want? Not what they say they want, or what economists say they should want, but what their day-to-day behaviour says about what they actually want in practice. And moreover, how can advisors avoid disappointing them?

We also spent a while discussing the idea of nudging. I wondered about the type of nudges that Dan’s research suggests might be helpful and how he thinks about navigating the fine line between nudging and manipulation.

Lastly, we discussed how Dan’s understanding of human behavior factors into Betterment’s portfolio construction and lessons learned along the way.

Dan is a data junkie and his unique perch has allowed him to gather critical insights into how humans interact with markets. I came away with some practical insights applicable to almost every facet of our investment business. Please enjoy my conversation with Dan Egan.

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Daniel P. Egan
Director of Behavior Science and Investing, Betterment

Daniel is currently in charge of Behavioral Science and Investing at Betterment, where he integrates behavioral finance and passive investment management to help customers achieve their goals.

Read Daniel P. Egan’s full bio here.

Transcript

Rodrigo Gordillo:  00:00:06           Welcome to Gestalt University, hosted by the team of ReSolve Asset Management, where evidence inspires confidence. This podcast will dig deep to uncover investment truths and life hacks you won’t find in the mainstream media, covering topics that appeal to left-brained robots, right-brain poets and everyone in between, all with the goal of helping you reach excellence. Welcome to the journey.

Speaker 2:               00:00:28           Mike Philbrick, Adam Butler, Rodrigo Gordillo and Jason Russell are principals at ReSolve Asset Management. Due to industry regulations, they will not discuss any of ReSolve’s funds on this podcast. All opinions expressed by the principals are solely their own opinion and do not express the opinion of ReSolve Asset Management. This podcast is for information purposes only and should not be relied upon as a basis for investment decisions. For more information, visit investresolve.com.

Adam Butler:          00:00:54           Hello and welcome to the Gestalt University Podcast brought to you by ReSolve Asset Management. My name is Adam Butler. I’m the Chief Investment Officer at ReSolve, and I am the host of this podcast. Today, I am very pleased to bring you Dan Egan who is Director of Behavior Science and Investing at the online advisor Betterment. In launching his rather unique career, Dan levered a master’s degree in decision science at the London School of Economics into a role as behavioral finance specialist at Barclays Wealth in London before moving onto his current role at Betterment.

With 15 years operating experience at the cross-section between human behavior and markets, I wouldn’t hesitate to say he’s one of the world’s foremost experts in this rather specialized field. To kick off the discussion, I wanted to know what do investors really want? Not what they say they want or what economists say they should want, but what their day-to-day behavior says about what they actually want in practice. Moreover, how can advisors avoid disappointing them over and over again.

We also spent a while discussing the idea of nudging. I wondered about the type of nudges that Dan’s research suggests might be helpful and how he thinks about navigating the fine line between nudging and manipulation.

Lastly, we discussed how Dan’s understanding of human behavior factors into Betterment’s portfolio construction and lessons learned along the way. Dan is a data junky to say the least, and his unique perch has allowed him to gather critical insights into how humans interact with markets day-to-day. I came away with some practical insights applicable to almost every facet of our investment business. Please enjoy my conversation with Dan Egan.

Dan, welcome.

Dan Egan:                00:02:44           Thank you.

Adam Butler:          00:02:45           Yeah, I’m glad that we finally had the chance to connect. You look far more put together than our typical D and D session.

Dan Egan:                00:02:51           Very true.

Adam Butler:          00:02:52           I guess it’s during the workday and you don’t have your usual character dress up on with the horns and-

Dan Egan:                00:02:57           No horns, I know.

Adam Butler:          00:02:58           … carrying your sword around and stuff.

Dan Egan:                00:03:00           No. I think this is the first time I’ve worn a button up shirt in like a month and a half.

Adam Butler:          00:03:06           When they first started telling me at the firm that we were going to move the video, I had to say I pushed back pretty hard on that, because first of all I got a face for radio and second of all, I’m used to working from home, and I don’t really want to have to worry about my wardrobe when I’m on these things, but fortunately I think the COVID crisis has really relaxed standards around how people look and some of the distractions around…-

Dan Egan:                00:03:28           Great for people like you and me.

Adam Butler:          00:03:30           Exactly. I debated whether we should start with our discussion of Sci-fi. I know you’re rereading The Three-Body Problem at the moment, and I’m dying to have a bit of a jam session on that for people who have read it and there’s a lot of ground to cover there. I think we should leave it to the end and see how the discussion evolves and whether there’s room at the end for us to spend some time.

Dan Egan:                00:03:51           That is definitely its entire own chat. No doubt.

Adam Butler:          00:03:54           Totally agree. There’s just so much there. So your background, maybe just go into it for those who have been hiding under a rock and don’t know who you are.

Dan Egan:                00:04:02           My background’s very much applied behavioral finance. So back in 2005, I got a master’s degree at the London School of Economics in Decision Science. It was one of the only programs that was available at the time to do applied financial decision making, especially that wasn’t going to be overly academic to where they’re like, “Yeah, you could probably get in corporate or industry or apply a job with this.” Was just incredibly lucky in that during the program, I did some part-time work with a guy who ran a private equity fund, and I just did low level analyst work, math and stuff doing my valuing convertible bond, stuff that I was not remotely qualified to do, but he had patience and he gave me a shot, and it was a very educational year.

I did it for a year and learned that I definitely do not want to work in private equity. It was a little bit too” kill or be killed and various things. So, knew that I wanted to leave that job and again, got very lucky in Barclays Wealth. For those of you who don’t know, Barclays is a universal bank in the UK, so they do everything from checking and savings accounts to investment banking, corporate banking, and they had a wealth management arm that was hiring for behavioral people. They were going to take a shot at, “Okay, so if we bring on some of these crazy psychologist type people into a wealth management firm, how are they going to help us improve the services and propositions, and the processes that we use with clients?”

My director at that point in time, a more senior guy made the pitch, was able to put together a team of three people, me and two other people, and we worked within the bank doing the first year or so, it was like R&D into how people vary in financial personality in a way that you can map over to actual products and services. Okay, so people are different. Cool, but what does that mean for the portfolios you construct or how they’re going to interact with their advisor. Try to make it a little bit more focused specifically around the advisor and client relationship and how people are going to think about performance in their relationship.

It was a hustle for probably the first two years where you’re both researching and doing, you’re also going to client meetings, you’re pitching the advisors internally on the, “This is good. You can use this with clients. It’s going to be valuable. Let me teach it to you. Let me train you, I’ll come to the first meetings.” Et cetera. The first two years were really hard. We weren’t proven at all that it was going to work. 2008 hit, and it’s good to be a behavioral person during a draw down, because for some reason people think that you know how to magically stop people from panicking immediately and now is your time to shine.

So my career unintentionally is that countercyclical asset in a way, which is I didn’t plan but it’s nice. So I did that with Barclays after we built the program out with advisors. So it was running itself. I was still doing meetings, and clients, and publishing stuff, but the thing, the big work have been done and I was young and restless. They moved me to New York City actually to take over the US business and work there.

After about a year, both being comfortable and a bit restless, but also there was this thing that was bothering me, which was that everything I did was parsed or moderated through the advisor.

Adam Butler:          00:07:05           The prism of the advisor.

Dan Egan:                00:07:06           Yeah. It’s not a bad thing. They’re their own people. They have their own incentives, their own beliefs. One of the pieces of research that we did inside the bank was actually looking at when you have an advisor and a client and clients vary within advisor, how much does the portfolios that the clients ended up with they reflect the actual client versus the advisor. The answer was they looked a little bit more like they were all from the same advisor than from different clients.

Part of our proposition had meant to be like, “No, let’s tailor to the clients more and that wasn’t necessarily getting all the way through because of that.” It’s really funny, because I actually called it “The Three-Body Problem” at the time. There’s us, the clients and the advisors and there’s just a lot going on there. The other element was that you would implement things, service changes, advise changes, blah, blah, blah, and you weren’t really sure if they have the positive impact.

There was no high fidelity feedback loop empirically about what change we weren’t running randomized controlled trials. We weren’t really sure what was happening. We got good positive feedback and negative feedback from people, but it wasn’t hard scientific empirical stuff.

Adam Butler:          00:08:07           There’s also many degrees of freedom, because you don’t know the interaction effects between what the firm is doing, what the advisor is doing and some of the more direct interactions that you’re trying to cultivate.

Dan Egan:                00:08:16           Absolutely. The opportunities that came up with Betterment where I was like, “Wait, I could do a lot of what I’m doing now.” Have a much larger sample size, because the one thing a Robo-advisor is definitely meant to do is to scale really well, bring a lot of the thoughts that I’ve been having around the design, how we report performance, how we help people think about goals or pots of money, however you want to talk about it, and implement it directly like in a technology company.

Those were one of the tough things I had in the wealth management business was a lot of the tech was outsourced in some fashion. If you wanted to change something, you effectively had to convince somebody at another company maybe to modify something. So there’s a lot of attraction around being at the company to control the design and the tech. I’ve been with them for seven years now, which actually it’s like I’m a dinosaur when it comes to the company. I am one of the most tenured people there. It’s been a wild and crazy ride.

Adam Butler:          00:09:02           You’re employee number what?

Dan Egan:                00:09:03           21. I’m employee number 21, but like Game of Thrones, I’ve managed to kill a large number of people who were ahead of me. I think I’m now, I don’t know the fourth or fifth most tenured person with the company.

Adam Butler:          00:09:14           You’re the Tyrion Lannister of Betterment.

Dan Egan:                00:09:15           That’s right.

Adam Butler:          00:09:16           Got it. So you’re at Betterment and your role at Betterment is an evolved version of your role at Barclays but with better data, more direct feedback loops, and an internal team that completely buys into your vision, or there’s a collective shared vision so that you’re all in the same boat, pulling the same oars and so a lot of the feedback that you’re able to pull out isn’t easily implementable and there’s buy-in from management to invest in the projects that make sense from what you’re seeing.

Dan Egan:                00:09:46           I’d say that a nuance there, is actually Betterment is in some ways a fairly flat place and another ways a hierarchical place. I have very little hierarchical power. I have no management. I don’t manage anybody. I’m what’s referred to as independent contributor or like a subject matter expert. A large part of my job is really more like hustling around the company looking at what people are working on, and what or how I could help them. That’s just like, “Hey look, the way you’re designing this flow is going to have some problem. Let’s see if we could switch things around in a way that’ll make it lower friction and lead to better decisions.”

That’s me trying to almost sell my services internally to product managers, designers, et cetera. The flip of that is that every once in a while I have an idea where I’m like, “Hey, what if we did this thing that nobody in the industry does because it’s very off the wall?” I get to pitch them that, because hopefully we have a relationship of respect and trust that they’re good intentions and it’ll be good for the client and the business and whoever it is.

No, I often say to people, “I have no authority. I just have a lot of influence,” but that influence comes just from hustle.

Adam Butler:          00:10:51           Do you directly interface with virtually every part of the business? You’re obviously on the client experience side, but are you also involved in the portfolio construction side, the investment side?

Dan Egan:                00:11:04           Yeah, I’d say my day is probably about I’d say a good 30 or 40% of the day is thinking about the intersection of advice, financial planning advice, investing in client experience and how those all should come together. Some of it is spent doing PR, for some reason being a talking head like this, listening and speaking directly with clients. So I’m responsible for some of the Twitter, or Reddit, really hard customer calls that come in where a normal CS person feels like it would be better responded to from somebody who has more gray hair, whatever it is like me do that.

Then a surprising amount of it is done trying to visually design things even internally to communicate ideas. One of the things I’ve learned is we do a lot of design stuff online. Everything’s done through apps, and websites and everything. The ability to show somebody the visual of an idea and how it works is very, very powerful.

Adam Butler:          00:11:55           Now, that makes sense. So you’ve had seven years of Betterment, you had what, two or three years at Barclays?

Dan Egan:                00:12:00           Seven.

Adam Butler:          00:12:01           Seven years at Barclays. So you had 14 years of observing investors and how they interact with money and with markets. I wanted to start as my first major core theme for this conversation with the question of what do investors actually want? What I mean is not what should they want, not do economists say that they want not what clients themselves say they want when surveyed. What did their behaviors when interacting with markets and money imply that they truly want without a shadow of a doubt? What do investors really want from advisors, from markets from their investments?

What Do Investors Actually Want?

Dan Egan:                00:12:41           One of the big lessons I’ve learned over the years is that there is way more diversity amongst people than any reductive model would let you believe. I’ve learned that by looking at the different client. When I was at Barclays, there was the advised client base that we mostly interacted with. They also had a DIY stock brokerage base that was I believe 25 to 27% of UK online brokerage trading. Even working with data between those things you see how different people are.

There are different life circumstances, different experiences that have really informed them through their lives about what money is, how it should be traded, and everything. So another one that’s been super interesting is that was a self-directed stock brokerage thing, similar client sizes and ideas of how many people are doing this at Betterment. Betterment clients act fundamentally differently. You just have a different -Vanguard clients act differently than Robinhood clients.

One of the real things that I grapple with is that we sometimes want to talk about people or investors as if they’re this consistent monolith and they’re just not. They’re all over the place. I had somebody write in recently and I was having a conversation with him where to them, they felt like they really needed to do aggressive speculative trading, because they needed the money. They’re out of work right now. They had a hustle job before COVID happened, and they’re like, “There’s no pride in this. I’m not talking to anybody about this. I’m not trying to even beat the market. I need money so that I can pay rent and everything.”

So everything from the most basic to much more social things. One would be able to chat with other people. This is one of the things that I think advisors sometimes underestimate is the degree to which investing, especially now is social. You want to be able to talk to other people or at least men do you usually about Netflix, and Amazon, and stories there, and what are you invested in, and what’s going on in the news.

Adam Butler:          00:14:26           How do you facilitate that as a Betterment? Do you facilitate that with internal professionals who are guiding conversation or do you facilitate it with message boards or you just try to stay away from that and coach people to try not to listen to that stuff. How do you guys approach it?

Dan Egan:                00:14:41           I try to avoid the negatives of saying like, “Oh, don’t do that. That’s bad. Don’t think about that,” and rather give people substitutes that they can feel more comfortable about. Talking to them about things like asset location or tax loss harvesting or different strategies like socially responsible things, things that aren’t strictly about raw market performance. So that if somebody’s like, “Oh man, blah, blah, blah is up this much,” you just have something that you can add to the conversation that is different, but still you’re going to feel, “I think this is a little bit what I’m trying to get at.”

You should be able to give your clients some level of confidence and comfort that when they’re talking about these things, they have something to say. They have something to communicate. I think we don’t go down the single line or speculative stock route, but we should still be talking with clients about, “Here’s some interesting stuff going on. Here’s what happened with policy around the cares act,” and giving them things so that they can feel comfortable talking to their friends and family about it without it being about single stocks.

Adam Butler:          00:15:31           Okay, and you find that that model scales that you can write or provide webinars, or provide some content that satisfies that itch in a scalable way?

Dan Egan:                00:15:43           The scalable thing is interesting. The way we think about it internally is we have to help nurture and create a community. So we’re on Reddit where people are chatting us, and I would probably guess eight times out of ten we don’t get involved in any of the threads, because they should feel comfortable talking about that without us. Where and when is a misconception or we can help clear something up. We want to go in and give ammunition to the right people to talk about things, feel comfortable about it and so on.

The scaling is less a function of anything direct from us. It’s not about strictly advertising on Instagram. It’s a matter of let’s keep investing in the people who get it and helping more people get it and scaling the community so that it has organic feel. The best thing possible is that one person uses Betterment, this is a very common thing actually, which is funny. There will be somebody who is sophisticated to financial services. Maybe they work at a bank or whatever else it is, and they really get the stuff.

They themselves don’t use Betterment or use it just for a small portion of their money, but every time they’re asked by their doctor friends, lawyer friends like, “Hey, what should I do with my money?” That person says, “Oh yeah, you should definitely use Betterment. They’re diversified. They rebalance. They do all of the stuff for you.” It is the good coherent safe option. There’s no minimums blah, blah, blah.

There’s a weird community feel to being transparent, trying to communicate a lot of the stuff in a way that is smart to the sophisticated people such that they feel comfortable endorsing you, but also approachable and comfortable to people who don’t have a background in finance.

Adam Butler:          00:17:13           I hear you. So everybody’s a rare snowflake, and they all have their own preferences. There’s got to be some drive down to some commonalities. What are the first three or four principle components here that explain a large chunk of most investors behaviors through time when interfacing with markets?

Dan Egan:                00:17:33           One, that you won’t be surprised about is it is better to be conventional and wrong than unconventional and wrong, and sometimes right. So people don’t like feeling like they made some very stupid decision that was different than everybody else’s stupid decision. There’s a lot of like, “Hey, what’s everybody else doing?” If all of my friends are going in on this stock or this idea, then if we’re all wrong together, ha-ha-ha.

That’s one is the idea of almost social safety that you’re not out on a limb in some unusual way. There’s a lot of social proof stuff that comes out there. General safety where I think once you’ve been in finance for a while you feel investing in various things are much less risky because you understand them. Going back to most people’s perspective, most people don’t really know what FDIC insurance is, but they know that it makes them feel really safe.

Doing things that are unusual, or risky or et cetera is so scary to a lot of people. I think the desire for safety is definitely something that plays a big role in most people’s decisions and there’s loss version, et cetera we can talk about.

Safety

Adam Butler:          00:18:39           So safety, I want to dig a little bit more to that. FDIC insurance is an example, but I don’t think that’s typically what people are thinking about as they’re contemplating investment decisions. How do people think about being safe? Is there an axis that is simplicity, familiarity, experience, some of these all enter in, but from my observation, there’s usually almost a U curve where people were just getting started with markets and investing. There’s a very steep learning curve to get up to speed on the very basics. What is a stock? What is a bond? How do you buy a mutual fund, that kind of stuff?

Then there seems to be this honeymoon period where once you get involved and you make a few investments, and because markets go up most of the time, so there’s this on average, when you get into it, you make money in the beginning because on average markets go up. There’s this feeling or perception of experience and intimacy with investing that you get very quickly. You know the basics and you’ve made some money so you feel like, but you don’t know what you don’t know. It’s this Dunning-Kruger Effect. Do you observe that at all in the data?

Dan Egan:                00:19:51           Oh yeah. I sometimes refer to this as climbing mount stupid. You have to get up there yourself and then come down the other side. One of the tricky things is that the atomic units of a lot of investing, you can talk to somebody about Amazon. The atomic unit is the stock and they hear about those things, and they can relate to them as consumers. You use these things. It’s actually a harder conceptually when you start thinking about, “What I should do is buy this thing called a fund.” A fund is going to buy all of the companies for me, and what’s the deal with taxes? How does this thing work?

Mutual funds in a lot of ways are much more complex even than ETFs, because an ETF is just on the stock market. You can go out and buy it much less restricted and complex. I think one of the issues is that, and you hear this all the time and I think it’s true. If you want to get people invested and interested in investing early, start them off when they’re young, give them a couple of single name stocks and they’ll learn about those stocks and about how that was super weird. Netflix went up and Nike went way down, and they need that experience of a little bit of the atomic level, some people, in order to build it up and then go, “Actually, maybe I just should buy all of them.”

This thing that charges four bips is perfectly good. I’ll just do that. Then I’ve simplified my life dramatically. I’ll be honest, I think a lot of men go through that especially the more competitive you are, the more likely it is you’re going to want to go granular. Women tend to be much more comfortable number one like thinking about their money and their investments purposefully and saying, “The important thing is that I can send my kid to college in 18 years, not that I’m invested in SPY versus VOE or something.”

They’re also less likely to seek out that competitive amount where you have to deviate from the average, where you have to deviate from market cap.

Client Education

Adam Butler:          00:21:28           Yeah, it’s the alpha in alpha. It’s alpha male I’m seeking my alpha status by excelling at this task. I forgot about this. I hadn’t actually planned on bringing this up, but my daughter this year for her grade nine class had a stock picking challenge as part of her business tech class. It inflicted an enormous cognitive dissonance on me because the objective of this challenge was you had to make a trade every two days. You had to make at least 50 trades over the six-week period of the challenge and whoever finished the challenge with the most money won the challenge.

Honest to God, I had no idea how to approach it. My fundamental grounding is diversification, risk aversion. Let’s go back to the basics. Let’s talk about asset allocation, asset allocation explains, depending how you look at it between 50 and over a hundred percent of total portfolio outcomes. Let’s talk about diversification. She was completely disengaged from that. I squandered this tremendous opportunity to engage with my daughter on this topic and on investing, and get her interested in investing, and saving and all that stuff. Because I literally could not connect with the objectives of the challenge.

Maybe you’ve got some ideas for people like that out there like me with this problem. How should I reverse engineer this, go back and make a better experience out of that?

Dan Egan:                00:22:53           I absolutely love this, because stock market, especially that thing what they put her in is what’s called, “A wicked environment,” because it’s like a noisy feedback loop that’s really delayed with low fidelity information coming back at you about what you did and where you have to be the best in order to win, which isn’t true in life and investing at all. It’s just in that weird narrow contract.

Adam Butler:          00:23:12           Especially over six weeks.

Dan Egan:                00:23:14           Yeah, Barry Ritholtz has a story he tells where when he was starting out, so I forget exactly what it was. Some client was like, “Listen, I’m going to try you and this other firm for the next six months and whoever makes the most money from me is going to win. I’m going to put it in.”

Adam Butler:          00:23:27           That happens all the time by the way.

Dan Egan:                00:23:28           Oh yeah, absolutely. People are really bad scientists, just because they don’t understand how this environment works. So he just picked up the phone and he’s like, “Listen, I’m going to tell you this right now. We’re not going to take you as a client, but I’m going to tell you why because what you just did is you say this, I am just going to risk your money. I’m not going to lose anything. I just swing for the fences. I’m going to put you in the riskiest stuff possible. It’ll be volatile. Maybe I’ll win, maybe I won’t, but the only choice you’ve given me is to do that to you.”

I want you to know that when you go out asking people to swing for the fences with your money, you’re also asking them to lose tremendously. I hope you learn something you know-

Adam Butler:          00:23:58           It’s a direct analog to the game of chicken.

Dan Egan:                00:23:59           Come back.

Adam Butler:          00:23:59           Two player chicken.

Dan Egan:                00:24:00           Yeah. So broader context, what do brokerages want you to do, especially these DIY online brokerages? How do they make money? Will they make money from selling order flow? Maybe trade commissions if they’ve still got them. When you hold cash, they make margin on it. They can lend your securities and maybe they’ve got some buy ups like leverage and margin and so on. They want to encourage those activities. They don’t care if you’re really good at them. They just want you to do them.

When you look at the design of a lot of brokerage apps, they intentionally have poor feedback loops built into them. They do not want you to learn if you’re particularly good at some decisions or other decisions if those things reduce your trading. Two big studies pop into my mind. One of which was a study of day traders, and I’m talking about daily day traders that was done where-

Adam Butler:          00:24:48           Did you say daily day trader?

Dan Egan:                00:24:49           It’s even worse is in Hong Kong and it was with some huge sample of individual traders. What they’re basically looking to do is like how quickly did people learn whether or not they should be doing this? As you said, it’s very easy to come in and if markets are going up and you’re in high data stuff, they’ll think that you’re a genius. What they found was that again with people trading daily, it took them about two and a half years to figure out whether or not they should stop or keep going.

Something like, I forget what the numbers are, it might have been one in 10 and two or 10 people were actually skilled and have persistent alpha, and everybody else probably should have stopped. It’s a very expensive tuition to pay to spend your time day trading for two and a half to three years to learn that you shouldn’t have done it in the first place. That’s very much somebody who wanted you to keep trading.

There was a study out of Germany that was done with a bunch of behavioral finance people and the brokerage where I believe every month, they sent people a report that was designed by the behavioral finance people that told them about their diversification, the quality of their trades, whether or not they were paying a lot in transaction costs, or taxes, or whatever what it was. They found the single largest effect of sending people this higher quality feedback loop was that they traded less.

It was good for the people, but the brokerage probably was like, “Great. We know what to not do now. That’s great.” My view on it is you need to number one, and I’ve talked with the people at Betterment about this. What does a Betterment self-directed brokerage product look like? It’s going to be something that nudges you to build more diversified, lower cost portfolios. They have less idiosyncratic risk. It’s going to help you with both pre-decision and post-decision analytics to say, “Here’s where you seem to make good decisions. Here was where you tend to make impulsive decisions,” and have a high quality feedback loop so that people are actually getting an education out of that School of Hard Stocks experience rather than being able to be deceived about what they’re good about at.

Adam Butler:          00:26:42           Just trying to loop back to my daughter’s investment challenge. How can I as a father who’s interested in investing teach positive lessons about long-term investing, and saving, and positive habits while also allowing my child to get excited and engaged with the process of investing? Because I couldn’t square those two objectives in my mind. So I was an epic failure, because I kept skewing to responsible practices and completely missed the opportunity to create excitement and engagement. How can I best balance those two objectives?

Dan Egan:                00:27:21           Honestly, I think it’s really hard with kids that young, because good investing is a bit like farming. Really, if you’re nailing things, you’re thinking over multiyear horizons and you’re excited about the process and the inputs that you’re following, not necessarily what’s happened over the past two weeks, because nothing meaningful has happened over the past two weeks. One thing that’s tough that I think we actually need to lean into more is that good learning involves pain. It involves negative feedback sometimes.

I often think about this. There’s not a huge, but a minor parenting philosophy difference between me and my wife. I’m actually quite comfortable and happy with my daughter hurting herself in little ways. I want her to climb that tree and fall out of it and get hurt a little bit. I want her to let go biking and go a little bit too fast and then get hurt a little bit, because she has to have that experience herself. I don’t want to cocoon her in it.

I do think there’s benefit to putting people in positions where they can learn themselves about the negative feedback loops, but I don’t want her to break her arm. I want her to get some bumps, so that she has some sense of her own skill level and fragility. One is actually go out and let them hurt themselves a little bit. A little bit, that’s good. The other is thinking about getting them excited about those farming concepts that are a little bit long-term like compounding.

When you’re a kid, how do you know about compounding? If I start talking to you about zombie apocalypses and how the zombies went it’s only like three days in and there’s eight of them, it doesn’t seem too scary, but the day before it’s a hundred percent of the population that’s only going to be 50% of the population, you can start to work it into their mindset of like, “Okay, I’m going to underestimate early growth. It’ll actually work out pretty powerfully in the long run.”

I got to be honest, teaching really young kids about finances a little bit like teaching somebody skiing in a desert. They’re not actually doing it. There’s not a lot of relevance to them at that point in time.

Adam Butler:          00:29:08           There is no context to the experience, agreed. So I think the lesson really is that it’s a lose-lose if you try to make it into a lesson about investing, but you could turn it into a win-win if you turn it into an opportunity to have share time and shared experience, and not get too wrapped up in the theoretical or practical nature of the investing challenge. So that’s probably a reasonable takeaway.

Dan Egan:                00:29:34           The other good one that I think is underestimated again because it’s boring, but it’s effective is take your kid and say, “Hey, I’m going to open this account for you and put it into this very boring thing, bond, stocks, whatever.” They can’t do anything with it, and you come back in six months and you’re like, “Hey, you want to check your account?” “That’s interesting. I did nothing,” and this thing is up 8%. That’s interesting. You come back in a year and you’re like, “Let’s check that thing out.”

I think the key insight there is that they will be surprised how much they can gain by doing nothing and that’s the hard insight for a lot of people. There are very few areas in life where you can get tremendous returns by doing less, but this is one of them and that’s the hard concept to get in without experiencing it.

All About “Nudging”

Adam Butler:          00:30:10           Yeah, so you and I will have to disagree on that point, but that’s okay. We can come back to it. A lot of what you describe in your papers, in your articles, et cetera amounts to … feel free to correct me, but what I would call nudging, identifying areas where people tend to systematically make cognitive behavioral errors or that run counter to their stated objectives. So we’re going to institute systematic nudges to help people stay on track. Can you go into that a little bit from a practical sense about what that looks like day-to-day for your job?

Dan Egan:                00:30:48           There’s two levels to it. The most basic level is a little bit like you’re writing a book, or a document or something and you have to pick a font. No matter what you have to pick a font. There’s no such thing as not picking a font. Now, you can pick a font that is easy to read for most people or a font that’s hard to read for most people. You generally are going to want to pick a font that might both be distinctive but also easy for most people to read.

                                                                Part of that level of design is just knowing how fluid and easy to understand something is, when should we chunk things into different bits in order to make it be intuitive to people. It’s not even paternalistic in the sense of, “I know better than you.” It’s more just like, “Let’s make it super easy for you to absorb and really use this information in whatever way is right for you.”

There is a second level, which is a little bit more opinionated. Level two is a little bit, I think where we think about which is like Cass Sunstein who’s a behavioral guy says, “The decision that you would make if you are your best most informed person.” An example here is especially when somebody’s reacting to markets, this is an interesting thing. People tend to speculatively trade and invest more in taxable accounts than in their IRAs.

Despite the fact that actually that brings with it tax consequences. If you’re going to turn the portfolio, you should do it in the tax advantaged account.

Adam Butler:          00:32:02           Yeah, that’s really interesting.

Dan Egan:                00:32:03           So here’s a neat thing. So somebody is worried about markets, worried that they’re about to go down. They come in and they say, “I want to go to zero percent stocks. I want to go to cash.” They might at some level remember that that might bring long-term or short-term capital gains treatment with it, but they don’t think about it in that moment. They’re not going to go off and calculate their cost bases and say, “This is how much it’s going to cost.” What we do is we say, “Okay, totally fine. You can go to zero percent stocks. Just so you know, that’s going to cost you $250 in short-term capital gains taxes next April. If you waited 62 days, that wouldn’t be the case. It would be long-term.”

You’re putting this really relevant piece of information that wouldn’t be top of mind for them and right in front of them for them to incorporate it into that decision and make a better decision. If they still want to do it, they can totally do it, but you’re like, “You probably weren’t thinking about this and I want to make sure that you consider them.” What we generally find is we did an RCT on that and somewhere between depending on circumstances, 70 to 90% of people don’t go through with that allocation change to go to cash.

They might do something less extreme. They might wait a little while, but I view it as being like, “Yeah, we added to their thought process a really important piece of information they weren’t considering.”

Adam Butler:          00:33:14           What does RCT stand for?

Dan Egan:                00:33:16           Sorry, Randomized Control Trial. So the split test where you say like, “We’re actually … ” It’s not just observed behavior. We’re going to have a treatment and have a control and see how they vary.

Adam Butler:          00:33:25           Nice. You’ve got such a large sample size you were able to actually create experiments with fairly high power I would imagine, statistical power. That’s pretty interesting. Yeah. How do you judge what nudges are valid? Is there a statement of purpose or a statement of objectives that clients signed, that you can go back to and say, “You told me this is what your objective is. I feel justified in putting these guardrails and nudges in place to help to keep you on that track.” Is that how it works?

Dan Egan:                00:34:02           Yeah. I’ve actually written up this, within the behavioral community this is actually a really important thing, because it’s like nuclear power. You can use it for good or you can use it for bad. It’s not opinionated in its own power. Sarah Newcomb at Morningstar specifically put together a nudger’s code of ethics about this stuff that is very explicit about I’m not going to impose my values upon you. I’m not going to use this, the really unpleasant things like you can sign up online but you can’t cancel your account online. You have to call.

Putting friction into things that are actually in the consumer’s discretion is not a cool thing. Actually, there are opinionated, they are principles, they’re not specific, but they are principles about what and when you are allowed to do things. I would say that I do not like forcing people to try and take my values to think that I’m right, but I want to make sure that they’ve considered the relevant information.

I want to make it really easy for them to do generally the right things. Investing is new and complicated and a little bit scary to a lot of people. One of the tensions that we deal with, it’s about how people are different is like how complex or involved do they want to be in their portfolio? A lot of people, they come in and say, “Hi, I’m investing for retirement, I’m this many years old.” They want us to tell them what to do, and they don’t want to get into a conversation about factors and what the valuation of the market is right now and everything.

They’re like, “Just tell me what to do and I’ll trust and believe you about it.” We have to have an easy path for them to click through where we’re asking questions to make sure we’re getting at the really relevant stuff to get them to an easy place where like, “Okay cool, I’m in 80% stock portfolio because I’ve got 25 years, blah, blah, blah.” The opposite side of that is what I consider flexibility or the ability to express yourself if you want to where you get to a screen it’s like, “Okay, we’re going to put you into our default portfolio. Do you want to choose something else?”

The people who have thoughts and opinions about that click on that and say, “Okay, I want to build it myself, or I want to have a factor strategy, or I want income, or I want a socially responsible thing.” That’s actually I think one of the more so than any kind of paternalism, the thing that I struggle with is building it so that it’s really easy for most people to use while allowing for people to be different in some easy fashion. Complexity and flexibility are two sides of the same thing.

Adam Butler:          00:36:21           They are. Absolutely. These specific studies in the systematic decision making literature, one specifically comes to mind where they gave people an algorithm that automatically made decisions for them, they described the logic that the algorithm uses to make decisions. They demonstrate the efficacy of the algorithm in making good decisions more often than not. Then they introduce the second group where they slight tweaks to the algorithm. Then they observe compliance with the degree to which they stuck with the decisions or went with the decisions of the algorithm over time.

The ability to have input into the algorithm no matter if it’s super small in terms of the practical affect on decisions, that ability to have your own stamp on it made a huge difference with compliance. Do you observe that or is that something that you bake into the cake?

Dan Egan:                00:37:20           Yeah, very much so. I love those papers in case anybody’s wondering – Berkeley Dietvorst is generally the author Algorithm Aversion. They are very, very well done papers and some of my favorite recent papers. One example I can give that’s interesting is when somebody comes in and tells us about their time horizon and what the purpose of the money is, we’ll give them a recommendation let’s say 60% stocks. They are able to change that and we actually put little boundaries on it where it’s like if you go up to 75% stocks, we might say, “That’s pretty aggressive,” or if you go down to 35% stocks we might say, “That’s really conservative.”

What we find is that I don’t know, something like 60 to 70% of people take the dead on recommendation without looking at it. Probably the remaining, I don’t know, 30 or 40% will go right up to the edge of those boundaries and sit right on the edge inside. They want to be as aggressive as possible within our recommendations and then they’ll just sit there. Then there’s some people who go outside of either way. That’s a great example what genuinely one of the things I’ve learned over the years, a lot of people are like, “Don’t let people do things. We shouldn’t let people do X.”

It’s like, “No, no, no.” You should totally let them do X, actually to just make it super easy for them to do that safely in a way that you don’t mind them doing.

Adam Butler:          00:38:33           Interesting. It really is almost like a bi-modal distribution. You’ve got a majority of people that are very happy to have it set for them and then just move on, but those that don’t want that want to take it to the extreme. That’s such an interesting phenomenon. It’s not a normal distribution. You’re either there or you’re there. How do you explain that?

Dan Egan:                00:38:53           To be clear, what we’re talking about is we recommend 60% stocks and if you go above 70, we say you’re very aggressive. So people don’t go to a hundred. They just go to 69.

Adam Butler:          00:39:02           No, I understand they go right to the barrier where they say that you’re being imprudent, but I just want to know why we wouldn’t have some in between. Why wouldn’t there be a normal distribution of people who, some people want to be slightly more conservative. Some people want to be vastly more conservative and vice versa on the aggressive side. I think it’s an interesting phenomenon that you’re either happy to just go right in the middle or you need to go right to the edge of what is recommended. I don’t know. I don’t know if you have any thesis on that.

Dan Egan:                00:39:29           I think people find it so much easier to think in either binaries or categories than intermediate numbers. What they’re looking at is there’s moderate and then there’s aggressive and I want to be aggressive, and I’m just looking at that category and I’ll put it wherever that is.

Adam Butler:          00:39:43           It’s high, low, or medium or positive, negative or zero.

Dan Egan:                00:39:46           Exactly.

Adam Butler:          00:39:47           That makes sense. Are there any embedded set of preferences or assumptions in the nudges? I’ll give you an example. You made a claim or not a claim, but a statement earlier that the best lesson for somebody to learn early is that you could keep it simple. You can keep saving and do nothing and things will work out. Doing nothing is the best thing to do is a baked in assumption. Is that first of all a baked in assumption? Are there other baked in assumptions that are actually really important to the long-term outcome, but we just take as so fundamental as to not be worth questioning?

Dan Egan:                00:40:24           Absolutely, yes. You can’t build something without having some I don’t know, base assumptions you’re going to move from.

Adam Butler:          00:40:31           One of them is they state their belief system and they state their objectives upfront. Now, just forcing people to state things within the boundaries of a form means that there’s assumptions baked into the options available on the form, unless you allow them to write out their set of beliefs and their beliefs are not going to change over time and just forcing them to write down beliefs means that they’re just going to make something up even if they don’t actually have strong beliefs.

I agree kind of that there’s not really … and then how do people change their beliefs through time both in terms of thoughtful changes in belief. I have had this experience I’ve learned lessons or I’m in a different stage in my life and therefore I want to approach the problem differently. How does that evolve through time and do the nudges evolve with that? In general, how do you think about some of those harder concepts?

Dan Egan:                00:41:26           It’s very, very difficult. One of the most difficult things has been what I think of as the design versus let’s call it financial literacy aspect of things. I have absolutely nothing against somebody being more financially literate. The more you want to read and understand stuff, the better. Yes, we should write articles. We should make them available in the app in timely ways, so that you’re motivated to read them right when you get them.

One of the tough things on the opposite side of it is we want to provide a service that frees our clients from having to do that. This is one of the tough tensions. Your doctor doesn’t say that you have to become a doctor to get medical care. Your dentist doesn’t say you have to become a dentist, et cetera. There’s a big percent of the population. You want to just, “I trust you. You’re going to do the right thing. You’re going to try your best,” and that frees me from not having to learn and know all about the stuff. So I can go off and be a good dentist or lawyer or whatever it is.

That’s a really good element of it, but that also limits the complexity and the conversations that you can have with them about what you’re doing. A great example is asset location. I don’t believe this is a particularly controversial claim, but these assets and these accounts, and these ones in that and it’ll grow after tax. After you’ve been around in the mix for a while, this just completely makes sense like, “Yeah, of course, that’s a smart thing to do.”

When we launched it, we’d have to have some tough conversations with clients who are like, “Why is my IRA different than my taxable account? What the heck is going on here? Why would you do that?” I think that the attention there is like if you let something atrophy, because you’re not exercising it all the time or you’re not growing it, it might come back later to be a limitation upon how complex or sophisticated or strong you can use something.

At the same time, the fact is a lot of people want to be freed from … If you could have abs without going to the gym, that’s the ideal solution. Sometimes people just don’t go to the gym, and sometimes they put in the time to get the abs.

Adam Butler:          00:43:16           There’s also some really interesting challenges in trust me. Trust me implies that you know my objectives. I’ll give an example. We have as a firm, long believed that a global diversified I’ll call it risk parity, but really just I want to maximize diversification across every way that you can possibly maximize diversification is the way to maximize the probability that you get to your end financial objectives, but a maximally diversified portfolio definitionally means that you’re constantly having to say you’re sorry, because it’s always going to be some segment of the portfolio that is on a tear, and ripping and then clients are feeling FOMO and they want to participate.

(F)ears (Of) (M)issing (O)ut

How do you know in advance what the FOMOs are or how do you short-circuit the FOMOs before they become FOMOs, or what are the solutions to this? Because this has been a really upfront and center problem for us in trying to do the right thing from a long-term objective standpoint, but constantly facing the uphill battle of FOMO. That’s a trust thing too though.

Dan Egan:                00:44:28           We absolutely have the same thing. Probably the most consistent dings we get is when US large cap is crushing it and anywhere else is doing less good. People might forgive you a little bit for a while if everything’s going up and just other things are going up slower. There was I remember some period, I forget when it was where US was positive and everything else was negative. Those were incredibly hard conversations to have. The answer is you still have to have those hard conversations and not minimize. It is very tough.

One of the ways I found most effective to talk and think about it is that if your only purpose is making what I would consider gross returns. So I’m not even talking about returns that are after tax, or after risk or anything. That’s going to be a really hard path to walk, because there’s always going to be something doing better or some …. The more that you can reposition the purpose of what you’re doing as something besides that, the more effective the client’s mental model is going to be the grapple with the issues that are going on there. Because it’s not going to be history based.

If we are doing something for tax purposes, it’s very clear we’re doing it now and it’s just going to help us next April because work is going to make us better off. If it is about the client’s goals, there are really good studies that show that the more that you identify specific purpose for your money, the more that it is virtuous and related to a specific person in your life. If you put pictures on it, the more well-behaved you’re going to be in managing that money.

Dead simple, we have clients who have goals that they name like, “Get rich or die trying,” and we have clients who name goals like, “My daughter Julie’s college education fund.” I can just look in that and I’m going to tell you who’s going to be whipsaw market timing and who’s going to be saving really consistently because how they’re thinking about it.

Adam Butler:  There’s a grass that’s always greener element too where there’s the Thanksgiving risk and cocktail party risk.

One of the interesting things about Betterment’s platform and we do the same thing, we are constantly putting out performance, we’re constantly being transparent, because we want to arm everybody with all the information. We don’t want to obfuscate but, what that also means, because that’s not universally true first of all, which means that any advisor out there who’s trying to coach your client could show any account they want, maintain as though that that is the experience that all their clients had.

In fact, it could be the experience that all their clients had because they happen to have luckily chosen to be concentrated in the market segment that happened to have done well over that specific period. There’s an infinite variety of permutations for how that could work. Clients are social beings typically, especially men, competitive animals, they’re out at cocktail parties or at Thanksgiving, everybody’s sharing how their advisor, their portfolio is doing and why, or why they think it’s doing well or not.

These are all elements that need to be factored in. So doing the right thing is this constantly changing ephemeral thing that you can anchor it to goals but then what are we doing here? We’re trying to save for your child’s education, or we’re trying to save for your retirement. That’s fine, but this other guy’s gonna help me save for retirement better. Why am I doing what you guys are doing instead of what he’s doing? I guess you’d go into stuff like better asset location and tax loss harvesting.

These are all really important elements in differentiating features, but they’re not the only criteria that people are using. It’s an impossible decision making process for most clients and it’s almost better to just have blinders on, assuming again that you could trust the person that you have given your funds to, to be doing the right thing and that they know what they’re doing because there’s two different dimensions to it.

Dan Egan:  One of the most interesting tensions too is that trust thing especially in    terms of personalization, and I love this, because my parents are in their 70s, and as you can imagine I pitch them occasionally and they could use Betterment for their retirement assets and so on. They put a bit in and they’re like, “We still want a human being who we can meet face to face and talk to about these things.” It’s like, “Get to know us, and we can get to know them and so on.”

It’s interesting, because there’s that side of it and here’s a really interesting other side. We generally, if you look at most directed brokerage apps, I’m going to say anything that’s not a 401K where the employer has defaulted you into having that account, you are going to find somewhere with five to maybe 20% female clients. 20% is pretty darn good for like a self-directed brokerage app.

When I was at Barclays in the UK, we actually were trying to figure out how to get more women interested in self-directed investing in various things and went out to, I forget what it was, 5 or 10% of women who were clients and we’re like, “Hey, we want to talk to you about this thing. Let’s have a survey. Let’s talk to you.” We found that something crazy like 50% of them were just tax wrappers who’ve been opened by their husbands who were actually the ones who are managing the account and were going to talk to us about these things.

One of the things I’ve found interesting at Betterment is that we weigh over index on women somewhere about, I think it’s about 35% of our accounts are owned by women and they’re generally like, it’s their account and so on. More anecdotally, less statistically, one of the things that I’ve heard is that women and minorities are more likely to use Robo-advisors, because they know they’re not going to be discriminated against. It’s something that they might perceive or go in and they’re like -comes from my parents who were like, I would really like there to be an old white male who I can talk to about this.

Those groups of people are like, “I would really like somebody to not treat me, like it’s weird to think about, but I want them to treat me like a number because I’m worried about how I might get treated otherwise.” There are really weird different undercurrents about how people perceive this trust thing that I didn’t even see coming, but are definitely there.

Trust Vs Compentency

Adam Butler:     00:49:54    That’s a really interesting point. Absolutely. This trust versus competency thing is just incredibly complicated. I really do sympathize with investors and clients, because the people that seem the most trustworthy, seem the most empathetic, I’ve spoken to a large cross-section of advisors who have very targeted markets. Some of them would target women, specifically because women want to deal with other women. So I’m going to target divorced women, because they don’t trust men. They typically have a large lump sum of money.

When they were married they were often not as involved in the financial decision making, so they’re very intimidated by that. Therefore, for all these reasons they like to deal with a woman. These women advisors will be able to gain trust very quickly. That’s a target market and that’s their business, but there is very little overlap between trustworthiness or the ability to gain trust and competency.

So great. You trust me because I’m a woman, because I can empathize, because I have a lot of other clients in your group who you socialize with this peer group who you identify with and trust, but it has nothing to do with my competency to manage your money or be affected in designing your estate plan or what have you. So there is this really difficult, because trust is not all there is, trust is necessary, but it’s not sufficient. Competency is necessary, but it’s not sufficient.

If you’re on the outside looking in, how do you judge competency? You can’t and therefore you default the trust, which is why you got all these nice paneled offices and manicured hair and veils and suits and what have you, because these are signals of that you should trust. In my experience, they have nothing to do with competency. I think it’s interesting that the Robo solution short-circuits all that stuff. You are not going to appeal to people who prioritize trust, or at least that’s not immediately who you’ll appeal to, but rather there’s these other dimensions of preferences that make defaulting to Robo really attractive.

Dan Egan:                00:52:09           Here’s an amazing one that we didn’t see coming. We started looking at who our biggest blocks of clients were, and there was a whole bunch of tech workers that was like, “Yeah, check. Okay, we get that.” Then there was a whole bunch of armed forces members. We had not targeted. There was no trying to do that. A lot of them are deployed overseas. They want to know that somebody’s taking care of stuff and that they can move money and coordinate with their families back home while they’re remote. They might be in a different time zone. Calling might not be an option so they’re like, “Yes, Robo-advisor. I can do everything through the internet. I can get advice through the internet. That sounds great.”

Behavioral Portfolio Construction

Adam Butler:          00:52:38           Very interesting. Wow. You are somewhat involved in portfolio construction, right? Before we wrap up, I do want to talk a little bit about how the behavioral insights helped you inform how portfolios are constructed and how … what you have learned over time has maybe around the edges caused you to evolve the way that your portfolio is constructed.

Dan Egan:                00:53:00           Well, number one we wanted to be, our portfolio I think to be sort of as like, I don’t know if vanilla is the right word, but noncontroversial as possible. We wanted to be the simplest narrative story possible so that we could move on to discussing other things. Like a lot of financial planner people would say, “I want to talk about your plans and what the money is for and how we’re dealing with retirement and everything.” So some part of it is we want to be transparent, low cost, diversified, easy to get in and out of, all the normal stuff that you’d look at at a portfolio, but almost to say, “Yeah, the portfolio follows really good principles –  all of those things.”

Adam Butler:          00:53:36           Such as?

Dan Egan:                00:53:37           Diversification, low cost, liquid, independent. I think that’s actually one of the ones that it’s tough to get people to clock on, which is we don’t have our own funds. You’re not getting put in Betterment funds, you’re in iShares, and Vanguard, and State Street and whoever else. That means we’re independent. We don’t take any money from them, so we’re just constantly going out here trying to find whatever the best funds are. People actually say when they’re investing with us they’re like, “Why should I invest in your funds?” We’re like, “You shouldn’t. We don’t have any. I don’t know what you’re talking about.”

That was in some ways a motivation just to say, “We’re going to try and help you focus on saving, and taxes, behavior and other things rather than the portfolio.” Especially because once you get into focusing too much on the portfolio for … I’m particularly coming at this from the people who invest as a means to an end rather than because they really enjoy it and want to get their hands dirty. It can end up being this rabbit hole that you run down where there’s just tons of questions that don’t necessarily have any clear answers that go anywhere. That’s a first element.

One of the things that I’ve picked up on over the years, my principle where I started from was like, “Okay, let’s just go global market cap.” That’s the noncontroversial opinion to me is, “Here’s this basic thing.” If I could go back and see-

Adam Butler:          00:54:47           So markets are perfectly efficient.

Dan Egan:                00:54:48           Yeah.

Adam Butler:          00:54:48           The market is perfectly efficient. The average view is the best view, log work numbers, so global and market portfolios is sort of the base case.

Dan Egan:                00:54:58           Also mixed in there is like, I don’t know that I’m the right person to second guess it. It’s not necessarily that I know it’s perfect, it’s just that I don’t know that I’m going to beat it. So a little bit of humility. The thing that I think coming back to your diversification point, the thing that I underestimated was how hard it was going to be to have that international diversification discussion with people where either time that we spent trying to convince people or people just being upset about it, I would probably now move towards having not entirely, but a little bit more tilt towards the USA just because it makes people more comfortable and understand things a little bit more. It’s hard for me to tell them what you should do.

Adam Butler:          00:55:35           It’s truly balanced across global market cap so you’ve got 50/50 international and US.

Dan Egan:                00:55:42           Yup, absolutely.

Adam Butler:          00:55:44           That’s enlightened, I like it.

Dan Egan:                00:55:45           That’s what people say is like, “Wow, that’s principled. How do clients like it?”

Adam Butler:          00:55:50           Yeah, exactly. It’s always fighting this battle between trying to create the most efficient portfolio based on the most humble set of assumptions while also appeasing people’s other biases, FOMOs, the home bias, all those different things that factor in.

Dan Egan:                00:56:09           That’s like one of the fundamental things is you came to an advisor for advice that was going to do something different than all of the proclivities you would do yourself if it was natural to you. That puts the advisor in a really weird spot where they’re constantly trying to make you a little bit uncomfortable to move you closer to some better solution, but still going to make you be like, “But why didn’t we go all in on Netflix?”

Adam Butler:          00:56:29           Yeah, exactly. You’ve got individual level of data, right? Is there any investigation in the direction of, “I can custom tailor my client’s portfolio to better meet his or her individual preferences.” When I say preferences, that’s almost interchangeable with biases, but I find that he’s checking his or her portfolio more frequently under these conditions or he’s drilling into this segment of his portfolio more often, or I’m sure there’s these dozens of different dimensions that you might be able to pull data from to perform some analysis. Is that on the docket as something you guys want to explore?

Dan Egan:                00:57:13           Yeah. Thankfully, for years we have a very good data science analytics team that appease me by letting us run these sorts of things. At this point, the targeting of it at least in terms of things that are concerning. I think early 2018, there was a market draw down. I want to say that we got really close to 20% down in US. I’m doing this off the top of my head, and that’s again a great time for me. We get to go in and look at the data. What we are looking at was for every 1000 Betterment customers, about six of them de-risk their portfolio during that draw down. You’re like, “Okay, cool.”

Adam Butler:          00:57:45           It seems absurdly low. That seems like a tremendous achievement. That’s like DFA achievement.

Dan Egan:                00:57:49           Yup. It’s actually a problem for me because the size of the prize to change it is really low. Six in every 1,000 scale it up and I’ve only got 3,000 clients to save or something. So who are those six? What are the contributing factors to those six? It’s very easy to be like, “Oh, well they’re the old retirees who are worried about the market going down and blah, blah, blah.” Actually, if I’m going to predict who those six people were, they’re going to be young, they’re going to be men, they’re going to have lower account balances and they’re going to log-in a heck of a lot. The tough thing there is that it’s not a simple thing of, “Oh, I really should put you in a lower risk portfolio,” because what they want is high return and no risk. That’s what they’re trying to do.

Adam Butler:          00:58:28           Yeah, high upside capture or low downside capture.

Dan Egan:                00:58:30           Yeah. So that’s a really tough thing is that a lot of times, the purpose of them coming in, I would find it hard to tailor to prevent a lot of behavioral biases because the drive that is there is not about, I don’t know how to put it like something other than returns. It’s very easy to say like, “Hey, you freaked out last time. Do you want to go lower risk?” They were like, “No, I need the high risk so I can get the high return sit.”

Adam Butler:          00:58:52           Interesting. So there’s not enough craving for something different that you’re observing in the data to provide a motivation to drill deeper in that direction and invest in that?

Dan Egan:                00:59:07           No, that’s not actually the way I would put it. When people come in, this is one of the … I have a blog post that I meant to send it to you ahead of time. They compare investment strategies to religions or beliefs like narratives that you just believe in. It’s a leap of faith. This is my jam.

Adam Butler:          00:59:21           I’ve read that one. I’ve read that post. You got to have faith.

Dan Egan:                00:59:24           Yes, exactly. That’s where some people come in and genuinely, I think Leigh Drogen is super into factors and specifically momentum. He’s like, “Give me that. That’s my jam. I can stick through it regardless. Just give me my momentum.” West Gray would be like, “Give me value. I don’t care what happens. I’ll just keep going.” Whatever those narratives are, sometimes it’s market cap. People are like, “I don’t know, markets seem pretty smart]. Just give me that.”

Those are areas that I want to explore more. One of our fastest growing strategies that is not like market cap vanilla is socially responsible. We’ve not done anything to promote this. We don’t market around it a ton. That’s an option in there. It grows organically, and here’s a key thing, they’re incredibly well-behaved. When the market dips, they blink less than other people. The more that I can figure out what are those, I don’t know like narratives or belief systems that allow somebody to not care about the draw down in the portfolio, because they’ve got something else they’d be like, “It’s still right for me. It’s still the right decision. I don’t need to look at.”

Adam Butler:          01:00:27           It’s something that’s orthogonal to the profit motive. Yes, gee, it’s clearly, “I’m not doing this because it’s going to get me high returns. I’m doing this because I believe in social justice, or I believe in these causes. I believe that we need a sustainable future.” If that means that I need to accept lower returns, then that’s okay, because I feel like I’m achieving other broader objectives that I can’t just achieve with the profit motive to the extent that you can I guess cultivate values and beliefs that are orthogonal to the profit motive then you’re more likely to stick with it, because the profit is less of an explanatory variable in behaviors and objectives.

I think that makes sense. What do you think? Do you still have energy for a chat about The Three-Body Problem or are you brain-dead?

Dan Egan:                01:01:11           I want to refresh. I want to come in fully locked and loaded for that one.

Adam Butler:          01:01:14           I agree. Yeah. Okay, cool. We’ll save that. I also am going to bring in Ben Hunt and maybe Dave Nadig is going to want to weigh in on that.

Dan Egan:                01:01:20           Fantastic.

Adam Butler:          01:01:21           I got a couple of guys from ReSolve who I’ve nudged into reading it who are now total adherents. So, yeah we got to get into cosmic sociology and conjectures, and all that kind of stuff, all right, the dark forest, brilliant. It’s been fantastic.

Dan Egan:                01:01:36           Definitely.

Adam Butler:          01:01:37           I sent you an email beforehand going, “Hey, send me some papers.” Then I started writing out a few notes I’m like, “No way man, my brain is exploding with different directions we can go.” As usual, it didn’t disappoint. So really appreciate you spending the time and for your thoughts and insights.

Dan Egan:                01:01:52           Thank you for having me. Absolute pleasure man.

Adam Butler:          01:01:52           It’s been a lot of fun.

Rodrigo Gordillo:  01:01:54           Thank you for listening to the Gestalt University Podcast. You will find all the information we highlighted in this episode in the show notes  at investresolve.com/blog. You can also learn more about ReSolve’s approach to investing by going to our website and research blog at investresolve.com where you will find over 200 articles that cover a wide array of important topics in the area of investing. We also encourage you to engage with the whole team on Twitter by searching the handle @investresolve and hitting the follow button.

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